Why mortgage rates are climbing again: inflation won't cooperate, and the labor market is resilient

Today’s letter is brought to you by Prophetic!

On Wednesday, the 10-year Treasury yield jumped up to 5.13%, the highest level since July 2007. It was the biggest one-day move for the benchmark yield in nearly 18 months. That's a sharp reversal from earlier this year. The 10-year yield began 2026 near 4.15% and briefly dipped below 4% in February.

Mortgage rates have followed. On Thursday, the average 30-year fixed mortgage rate as tracked by Mortgage News Daily came in at 7.26%.

Much of the jump in long-term rates can be traced to inflation staying stubbornly above the Federal Reserve's 2.0% year-over-year target for five years, and to a few forces that are keeping the labor market tight.

Below is what’s driving borrowing costs higher this year.

The chart above breaks down year-over-year CPI inflation into its major components, weighted by their relative importance in the index. It tells the story of the past few years in three acts.

The first act was the 2021–2022 spike, when energy (dark blue) and core goods (gray) blew out as the economy reopened and it overheated amid stimulus/low rates. The second act was the long disinflation of 2023–2025. Energy and core goods faded, and shelter's contribution (yellow) steadily shrank from roughly 3 percentage points in 2023 to just over 1 point.

Notice what didn't fully go away during that second act: core services excluding shelter (black). That persistent chunk is a big reason headline inflation settled closer to 3% than 2.0% heading into 2026.

The third act is the one playing out now. Energy, which subtracted from headline inflation for much of 2023 through 2025, has swung sharply positive. Since the Iran conflict began in early March, WTI crude has climbed from near $57 per barrel at the start of the year to a peak of $113 in April, and it recently moved back above $100. By May, headline CPI inflation had jumped to 4.2%, with energy alone accounting for roughly a third of that.

There's been some cooling since. The Bureau of Labor Statistics reported that CPI was up 3.4% year-over-year in August. But that's still well above target. Energy costs don't stay in their own lane, either. Higher fuel and diesel prices feed into transportation and manufacturing, and eventually into prices across the economy.

For bond investors, the worry isn't just the current level of inflation. It's that inflation has been above target for so long that expectations risk becoming unanchored. When investors expect higher inflation for longer, they demand higher yields on long-term bonds. Those higher yields flow directly into mortgage rates.

While the Federal Reserve’s short-term policy rate doesn’t directly determine long-term rates like mortgage rates, there is still a historical relationship between the two. Long-term yields—such as the 10-year Treasury yield and the average 30-year fixed mortgage rate—are driven by investor demand for the underlying bond and are heavily influenced by market expectations for future Fed policy and the broader economy. Historically, when economic conditions push the Fed toward more restrictive policy, long-term yields and mortgage rates tend to rise alongside that shift. When conditions push toward more accommodative policy, long-term yields and mortgage rates tend to fall—often before the Fed even acts.

If the labor market were deteriorating, the Fed and bond investors might look past an energy-driven inflation bump. That isn't happening right now.

Between April 2023 and November 2025, the unemployment rate ticked up from its cycle low of 3.4% to 4.5%. However, it has since ticked back down to 4.1%.

Right now, the unemployment rate is within the Fed’s desired range; however, the inflation rate is above target—giving the Fed breathing room and justification for once again attacking inflation. On September 16, the Fed raised rates for the first time in three years, lifting its overnight lending rate to a 3.75% to 4% range. Markets now expect a few more hikes. Odds of another quarter-point hike in October rose to 70% on Wednesday, up from less than 10% a month ago.

A few factors are playing a role keeping the labor market relatively tight. 1. Decelerated net international migration has lowered the number of workforce people coming into the economy needs to add each month. 2. An aging population has impacted the overall workforce share of the economy. 3. And while consumer sentiment surveys have looked gloomy, the hard data on spending (including on data centers), corporate profits, and business activity have held up. Wednesday's yield spike was partly driven by much stronger-than-expected surveys of U.S. economic activity, especially in manufacturing.

One reason the labor market and the broader economy have stayed so resilient is the AI buildout. Just look at the chart above.

For most of the 2010s, U.S. data center construction spending grew at a steady clip. Then OpenAI launched ChatGPT to the public in November 2022, and the curve bent sharply upward.

Just as notable is what the chart doesn't show: any slowdown so far. Spending kept climbing through 2025 and into 2026.

That spending supports jobs, construction activity, and corporate investment. It also competes for the same inputs as the rest of the economy: electricians, construction labor, power generation, and memory chips. Fed leadership expects AI productivity gains to eventually be disinflationary. For now, though, the buildout is straining specific supply chains, and those productivity gains haven't yet shown up in the data.

Fed Chair Kevin Warsh acknowledged this backdrop. At his September 16 press conference, he said that higher 10-year yields have been driven by economic strength, competition for capital, and geopolitical factors.

Beyond the cyclical factors, slower-moving forces are also pushing up long-term yields. Federal debt now tops $40 trillion, and publicly held debt relative to GDP is near its highest level since World War II. There's little political appetite to address the entitlement spending behind that trajectory. Even if demand is steady, an increase in the supply of Treasuries can push yields up.

It's also worth stepping back. Mortgage rates above 7% feel high compared with the 2009 to 2021 era of ultra-low rates. But that period, not today, was the historical anomaly. In a world with sticky inflation above target, large deficits, a tight-ish labor force, and a capital-hungry AI boom, long-term rates around current levels make sense historically.

The nationally aggregated housing market has been passing through a cyclical cooling period ever since the Pandemic Housing Boom fizzled out in mid-2022. We're in a period where strained national housing affordability (factoring in U.S. home prices, mortgage rates, and U.S. incomes) is under pressure to recalibrate. Before the most recent jump in mortgage rates, U.S. housing affordability had been slowly recalibrating, with U.S. income growth year-over-year (+4.1%) outpacing U.S. home price growth (+1.2%)—and even bigger recalibration has been underway in Sun Belt housing markets, which are passing through outright home price corrections, and in the new-home market, where net effective home pricing has adjusted further.

However, the recalibration process has lost progress with the recent jump in mortgage rates.

Indeed, the recent resurgence in long-term yields and mortgage rates puts additional short-term strain on housing affordability for buyers, as well as for sellers who'd like to sell and buy something else. And in softer housing markets where that supply-demand equilibrium has already shifted further into buyers favor, buyers will have even more leverage during the seasonally soft window. In the coming weeks, we’ll begin to see what type of softening it creates for the nationally aggregated housing market beyond seasonality.

Last month, ResiClub added Minju Kang to the team as a Data Analyst.

Minju is a 2026 graduate of a master's program at Duke's Fuqua School of Business, and she'll be working on new developments in the ResiClub Terminal—data and analysis built to help our clients move the needle on their firm's capital allocation and investment decisions. Not just where local housing markets/building conditions stand today, but where the opportunities and risks will be in 3, 5, even 10 years.

Since launching ResiClub in October 2023, I've done over 1,000 calls and meetings with land investors, developers, homebuilders, material suppliers, single-family investors/operators, and lenders/banks—digging into their decision-making challenges, information gaps, and housing analytics pain points. Some of those, ResiClub has already addressed. Minju will help us address a lot more. We have a lot to build.

If your firm would like a demo of the ResiClub Terminal membership, reach out: [email protected]

Real estate agents/brokers can take the Q3 2026 Zoodealio-ResiClub Real Estate Agent Survey below.